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First the Bubblequake, Next the Aftershock
As of early summer, they had bought almost $1 trillion worth of these bonds and were expressing their willingness to buy even more over the remainder of the year. Ostensibly, these bonds are being bought to hold down mortgage rates, which it is doing. But, we think the more likely reason is that the government would have a hard time finding buyers for all this debt. Essentially, the Fed is playing the buyer of last resort, which is not a good sign. More on that later. The key for this discussion is that these bonds are all being bought with printed money—not taxes or borrowed money. That’s a lot of money to print. In fact, it is almost equivalent to our money supply as measured by M1, which is about $1 trillion. Although most financial and economic experts are expressing great confidence that this will have little or no effect on our inflation rate, it is hard to see how it couldn’t increase the rate substantially at some point. You wonder what they think will cause inflation. An often cited counter argument is that the lower velocity of money that we have during a recession will counteract the effect of printing all this money. Without getting too technical, in a very simple form you can think of the velocity of money as how fast monetary transactions take place. It’s kind of like how fast you pay your bills. In a recession, these transactions become slower. Velocity is also slower with low interest rates. The combination of low interest rates and a slow economy is reducing monetary velocity. However, like product price deflation, changes in velocity tend to be relatively mild compared to the massive changes in the money supply that the Fed is now making. There is also a natural limit to how slow velocity can go since people and banks want to hold as little as possible in non-interest bearing accounts or reserves. If the money is in interest bearing accounts, then it is being loaned out and is part of the money supply. If it’s not being loaned out and is not receiving any interest from that money, then someone is losing a lot of money. It’s not a sustainable situation in the long term. Banks may increase their reserves, but their lending would have to go down as a consequence. Higher reserves also hurt bank profits. Double-Digit Interest Rates. Double-digit inflation will cause doubledigit interest rates because interest rates always have to be above the inflation rate in order to get anyone to lend money. So as soon as we have double-digit inflation, we have even higher interest rates.